|I'm not the contrarian (May 2007)|
Bankers as salespeople? No way, says Joe Reid. Directors as governance experts? Get real, he says. Branching as the weapon of choice? I like a local charter, Reid insists. Could the straight-shooting Joe Reid’s Capitol Bancorp be the blueprint for community banking’s future?
By Steve Cocheo, executive editor
Joe Reid’s de novo strategy builds banks around talented bankers, keeps them small and locally focused, and keeps more coming. Capitol Bancorp just passed the 51-bank mark
It’s all about letting go.
At Capitol Bancorp Ltd., from time to time bankers reach a point where their territory gets chopped. Someone else gets a chunk of it.
And they are happy when this happens.
If that doesn’t make sense to you, then you don’t know Joe Reid and his company, nor do you get his concept of being a “bank development company.”
You aren’t alone. It steams Reid that some Wall Street banking analysts don’t “get it,” either.
“Every time I go to New York, somebody asks me, ‘What’s your exit strategy?’ Generally I look at him and say, ‘Same as Microsoft’s’,” says Reid, chairman and CEO at the $4.1 billion-assets company. “They wouldn’t dare ask Microsoft that question. Why the hell do they ask me that question? We don’t have an exit strategy.”
That’s because Capitol Bancorp isn’t about rollups. It isn’t about bulking up. It is, refreshingly, about banking. There is no exit strategy because Reid has no plans to exit.
Capitol Bancorp, and Joe Reid, to the many people, present a contrarian face, and even where Capitol’s aims match those of typical banking companies, management’s way of achieving those aims often differs from the norm.
In some ways, Reid’s model may be the elixir vitae that many smaller banks need to retain what is most important to them, and about them, in a time when many institutions with less than $100 million in assets fear for their independent futures.
Capitol Bancorp, with headquarters in Lansing, Mich., and Phoenix, has built a sprawling collection of community banks. The map on page 34 gives you an idea of where Capitol’s strategy has taken it thus far, and where it is heading. It currently has 51 banks (or loan production offices) in 14 states. In many cases the banks are clustered in and around certain markets.
Capitol affiliates handle credit decisions, local pricing, customer development, staffing, and all the other issues on which successful implementation of a business plan hinge. The holding company provides support functions.
No control freaks need apply
At Capitol, “you know that you’ve been successful when the amount of turf you used to have has been reduced,” says Reid. “That’s because we’ve had to bring somebody else in, to split the job up further. Many of our executives have had multi-task functions that have been reduced simply because of the size of their operation; because pieces of it needed more full-time focus.”
Reid’s operation has regional presidents in each of its eight regions, except the Northeast, where it is looking for one.
“I’ve told our regional presidents that their success will be measured by the contraction of the geographical reach that each of them has,” says Reid. Likewise, the more that the Capitol Bancorp clan grows, the more Reid expects to see the functional executives—the heads of Capitol’s centralized risk management, accounting, compliance, and similar services—bringing on more executives in their areas, giving up territory.
Reid himself has been a practitioner of this letting-go philosophy as Capitol has grown.
In its early days—the company was formed in 1988 in Lansing, Mich.—Reid would personally organize and chair every new bank that Capitol started.
“I’d stay at each of those banks until they were profitable—typically 12-18 months,” says Reid, 64, “and then I would withdraw. Well, that went fine for some time. But, you know, there’s only so many new banks a year you can bring on stream with that strategy, because there’s only so much time in the day for me.”
So, a few years back, Reid began looking for seasoned senior bankers who had the contacts and feel for their regional and local markets to do what he had been doing. In their regions, they oversee existing Capitol banks, and help establish, and serve as chairman of, new Capitol banks.
“Essentially what I tried to do was clone myself,” says Reid.
He still spends much of his time on the road, meeting with leaders of potential startups, and with existing affiliates’ leaders, but now he’s backstopped by a central management team that includes both a daughter, Cristin K. Reid, corporate president, and his son, Joseph D. Reid, III, director of bank development. Reid senior holds almost 15% of the company’s common stock, with the corporate board and corporate officers holding about 11%. Another 31% is institutionally held.
To the more typical mindset that stresses accumulation—building up more territory under your direct control, planting more flags, sticking more under your umbrella—Reid’s strategy may appear utterly foreign. Indeed, most of Capitol’s banks bear no obvious connection to the holding company in name, look, logo, or any of the other branding techniques that others place such importance on. And that’s by design, or, rather, nondesign.
“We don’t have a national brand, and we don’t want one,” says Reid. “Every bank has its own brand.” Some affiliates make a point of never mentioning the holding company, some do. “I let them pick whichever they want,” says Reid.
Indeed, Joe Reid’s concept of his holding company’s role defies conventional org-charting. Reid doesn’t even like calling it a holding company, instead preferring the term “bank development company.” Capitol’s corporate slogan is “the largest small bank company in America.” Reid has a formula of sorts, but his approach is not formulaic.
“If you started a hamburger place, and it worked, and you started a second, and it worked, you’d have a McDonald’s, and you would throw them up fast and they’d be instantly profitable,” says Reid. “Banking’s different.”
Other than an overall business plan stressing commercial banking over consumer banking, “all of our affiliates are different, even unique,” says Reid.
“I don’t send memos directing our bank presidents what to do, because it’s not that kind of hierarchical process,” he explains. “Our business isn’t to operate those banks. It’s to develop them and put them into a model that allows them to succeed because we know how to scale up some of the critical services that banks require.”
Neil Barna, president and CEO at eight-year-old Capitol affiliate Mesa Bank, near Phoenix, says, “Joe Reid told me, ‘If you put up the numbers we need from you, you’ll never hear from me.’ And I never hear from Joe.”
Gail Grace, president and CEO, at another affiliate, Camelback Community Bank, Phoenix, says Capitol in some ways resembles a vendor to its banks. A vendor who is her sole stockholder, she adds.
Don’t misunderstand the point of this strategy. Joe Reid isn’t running a democratic cooperative.
And he and his stockholders like money just like any other investors. Capitol has grown steadily in numbers of banks under its management—5 in 1994, 51 now, and, by 2011, plans call for 100—and in asset size. Revenue and earnings keep climbing, revenue at a compound annual growth rate of 23% from 1998 to 2006, earnings by a CAGR of 32%. ROE came in at 13.3% in 2006.
It’s just that Joe Reid and his team have evolved a way of doing banking that often seems to be oriented 180 degrees from what everybody else is doing. (For illustration of this—the way new banks are formed at Capitol—see the box, “Want a bank? I’ll meet you just past halfway,” p. 34.) The Capitol approach hinges on answers to key questions about banking.
1. Why take ‘banking’ out of banking?
Something important to understand about Joe Reid is that he isn’t a banker, not in the usual sense, and didn’t come from a long line of bankers. He grew up “first generation” in an Irish working-class family in Detroit’s Downriver section, had a successful law career, and got into banking almost as a hobby. He only abandoned the law after banking life got busy enough that he realized he could no longer keep a foot in both worlds.
But he holds banking in more veneration than do some bankers.
To Reid, banking “is still a profession, not simply a sales distribution function, not simply a marketing function.”
“A banker is a professional, like a lawyer, like an accountant,” continues Reid. “He has a great deal of client contact. He’s not there to sell a product, but to provide a service. Oftentimes it’s more in the nature of advice than it is in the nature of a loan. There’s still a market for that in America.”
Reid believes this is especially true for small business banking, which doesn’t lend itself to mass production and commoditization. Indeed, Reid questions the good of the entire, ongoing wave of consolidation. The American economy has been based on access to credit for entrepreneurs, he explains.
Local decisionmakers and local investors used to drive the banks that drove the local economies and things flourished. That is getting lost, and Capitol will not be part of the degradation, Reid says. Where local banking goes by the boards, he says, local business finds itself having to fit into some big bank’s template of what small business wants, “or they are out of luck.”
Instead, he thinks bankers should be in there, rolling up their sleeves, thinking of how to get loans done outside of the box. Reid decries the decline of “soft information” in banking, with too many deals being done strictly by the numbers these days, especially among larger lenders.
“When you go from 14,000 to 7,000 institutions, it reflects an insatiable appetite, driven by the Wall Street investor community, to further consolidate,” says Reid. “And so you hear absurd comments, things like, ‘The problem with the banking industry is that there are too many bankers.’ That’s a bunch of bull! There are not too many bankers. There are too few bankers.”
2. Why branch when you can bank?
One thing you notice about the evolution of Capitol Bancorp is its clustering of banks in markets that other institutions would tend to think of as branching opportunities.
“We are anti-branching,” says Reid. “We have a couple of banks that have branches, but we’re not good at it.”
“Our banks are ‘banks of destination’,” he explains, “not ‘banks of convenience.’ When people come to our banks, they usually get out of their car, even though we have some banks that offer drive-ins.”
Take the greater Phoenix market, or the Las Vegas market. In both cases, Capitol has chosen to establish multiple banks. The mix of approaches varies with the submarkets and neighborhoods targeted with each new charter.
The Capitol contingent in greater Phoenix, for instance, includes a bank chartered especially to serve the Asian-American market and another in development that will target the Hispanic market. CEOs, boards, and customer segments tend to be precisely targeted, and the emphasis is on smaller business loans, typically secured with real estate.
Reid says even in the same markets, affiliates rarely bump heads. CEOs say when the rare instance of chasing the same target happens, it gets worked out.
Whether the market is Vegas or a community of 6,000 people, Reid’s philosophy is the same: “To me it isn’t about the market, it’s about the leadership.”
To Reid, that is critical. And linked to his concept of a banker as a professional.
“Our entire strategy is based on staying small. These banks are driven by relationships,” says Reid. “Now, I know you hear that from lots of community banks. All community banks say that they are ‘relationship driven’ and they all say that they provide better service, take better care of their customers. And they do.”
But Reid says that for many such institutions, their success actually undoes them.
“The problem is, they grow out of it,” he explains. “The market demands that they grow, and they’ve got to continue to grow. So they open ten branches, 20 branches, and all of a sudden, they’re not what they were before. They’ve become something else.”
Unfortunately, says Reid, these bulked-up community banks begin to kid themselves.
“They grow large, and they’re something else,” he says. “So then they say, sure, but our people are great. Yes, but BofA’s people, Wells Fargo’s people, they’re all great too.”
So Reid prefers to open new banks, hence the clustering that sometimes goes on. “We just can’t get these banks opened fast enough,” he says. He’d rather open a new bank than let an existing charter grow too large—indeed, the company doesn’t pay much heed to relative size in the market nor to market share. Reid considers market share irrelevant to a banking professional.
“We want to get our new bank up to $150 million, which is almost a perfect bank for us, in terms of optimal performance,” says Reid. “I never tell a president, ‘You’ve got to keep growing.’ What I say is, ‘Get your bank up to a size where you’ve got your arms around it, you know what’s going on, you’re comfortable with it.’
Can you name me another bank holding company that’s driven by that?”
Camelback Community Bank’s Gail Grace puts it in a nutshell, from the CEO’s perspective: Growth, she says, is never a top item of discussion; the focus, instead, is on each bank’s profitability, notably, ROE. Indeed, CEO compensation is based on the ROE of their bank.
And Reid also has a strong rule-of-thumb for when a bank, no matter what its asset size, has grown large enough. And that is when the CEO begins thinking about taking his or her office off the main banking floor. To Reid, a major part of what Capitol banks sell is access to a real bank president, the chance to sit with the person with the decisionmaking power and look them in the eye.
“Why would we hide that?” he asks. “If they say they are moving upstairs because the customers are bothering them, then I know that bank is getting too big.”
Still, Reid acknowledges that as a NYSE-traded firm [Symbol: CBC], Capitol can’t ignore the growth mantra that Wall Street lives by.
“If you don’t light your candles at the altar of the gods of Wall Street, they’ll just tear you apart in no time,” says Reid. So he’s adopted the attitude that the local bank presidents in the Capitol family worry about the banking, and he will address the Street’s demands by keeping the string of bank openings going, which drives the growth that keeps analysts satisfied.
“That’s my job,” says Reid. “I take care of the ‘growth guys’.” His regret is that even after the Capitol model is explained, most analysts don’t buy into it because it is just too different.
Two or three analysts, over time, have understood the model, says Reid, one of them is Michael Moran. Reid wound up hiring Moran to be Capitol’s chief of capital markets, and a key spokesman for the company to the analyst community.
3. Why send in a stranger?
Typically, banks look for markets that seem attractive, and they either bank or branch into that territory.
Reid takes a much different view. He’d rather find a good banker and build around that banker.
Reid says the scenario goes like this.
“You’re president of a bank, and been so for a long time,” says Reid. “The bank is acquired, and they want to keep you because you know everybody in town.”
But before long, the new big owner moves credit decisions out of the local operation “to make the bank more efficient.” The longtime CEO gets frustrated, because he has become a figurehead.
When Reid meets with the banker, he puts it to him plainly: “If nobody was pulling you back, what could you hit a home run on?” This becomes the basis of the new bank’s business plan.
Good bankers, says Reid, are much like attorneys or CPAs. They bring their clients with them. “You only need that tiny chip off that market, and you are on your way.”
4. Why ditch your best assets?
While Joe Reid isn’t entirely comfortable with the “contrarian” label—he almost seems to think it is the industry that has moved away from common-sense standards—in perhaps no other area is he so clearly swimming against the tide than in the boardroom. In recent years, many banks have shrunk their boards, and corporate governance experts these days seem to favor leaner boards than were once common in banking.
But Reid simply loves bank directors.
“We’ve got more bank directors than any banking institution in the country,” he says. Capitol works the total directorate tally into presentations to the Street. In mid-March, Capitol stood at 22 corporate and more than 555 bank directors.
“When I partner with a new bank president and we put a bank together, I tell them that you need a board that’s somewhere between nine and up,” says Reid. He doesn’t favor simply filling the chairs, but concentrating on local figures who can help the bank get started. “But if I were starting a bank, ” says Reid “ I’d like to have about 18 directors.”
Reid favors local boards and lots of directors because, while they are full-fledged boards, he sees business development as their most important role.
“This is the best deal in America,” explains Reid. “If you hired a full-time business development officer, he couldn’t do what these folks can do for you.”
Reid acknowledges that regulators would say the board’s main role is ensuring safety and soundness. He disagrees, because he believes much today is wrapped up in systems that monitor a bank’s condition. Most directors don’t really understand these things, Reid says, and staff must interpret them, anyway.
Moving beyond the core
With its ever expanding geographic range, Capitol’s “portfolio” continues to take it beyond its historical base in the central states, notably Michigan, hit by ripples from the auto industry’s problems.
(Around 85% of its nonperforming loans come from Michigan affiliates. In a recent Street dog-and-pony, Moran was asked if Capitol ever considered selling affiliates. He said that has been considered, but never seriously. “It starts to unravel the model,” he said. “The others would begin looking over their shoulders.”)
“Our goal all along has been to build a material presence in every region of the U.S., because with that we believe that the predictability of our earnings will be more assured,” says Reid.
In 1996, most of the company was in the Great Lakes region. Now, 48% of the affiliates do business there, with 37% of the company in the Southwest, 9% in California, 5% in the Southeast, 1% in the Northwest, and short of 1% in the Midwest. New forays are taking the company into the Northeast, slowly.
While Reid’s basic game plan continues to succeed, he faults himself on one key point: noninterest income.
And, because he must handle Wall Street’s demand for growth, he’s taken steps to change that.
“If you look at our noninterest income, it’s about half of what an average community bank has, because we’ve been so fixated on loans and deposits,” says Reid. “I’ve frankly done a poor job at developing a culture for noninterest income, and the corporation has to take the lead on that because it’s complex, and the local bank presidents don’t have the time.”
What Reid is trying is wealth management, which he sees as a good fit with the consultative, business banking orientation the affiliates use. Capitol Wealth Advisors was announced in early 2006.
“I’ve told the Street, if we can just get up to average on noninterest income, that will be huge,” says Reid.
“And there’s no reason we can’t get there." BJ
“Want a bank? I’ll meet you just past half-way”
A key element of Capitol Bancorp’s de novo strategy is its “incubator” approach.
When Capitol starts a new bank, it doesn’t fund it solely from its own coffers. Chairman and CEO Joe Reid’s belief is that if a new bank is going to fly, it must have the interested support of local investors/customers, its own board, and its top management team.
Capitol, using special bank development subsidiaries, puts up 51% of the capital, while local interests put up 49%. The other, nonfinancial investment Capitol provides is logistical and administrative support, as well as a deep bench of experienced experts.
“We tell the board that they have to get about 150 investors,” says Reid. Capitol doesn’t want any big checks, no investment bankers. It wants local money, and won’t sell the new bank’s stock out of state. And, more specifically, it wants investment by people who will bring their banking business to the new bank.
“If they’re not going to open up accounts,” Reid warns the new board and team, “do not give them stock.”
This way, “everybody’s incented to get the bank up and running and profitable,” Reid explains.
Typically, after three years, when the new bank is going into the black, Capitol offers to exchange the local bank’s shares for its own stock.
The usual rate is at about 1.5 times book.
Frequently, Reid says, he’ll hear the minority investors point out that a bank down the street sold for, say, two times book.
“My question is, how long were those stockholders in the deal? Because a 50% premium after 36 months comes out to three times book over a 12-year period,” says Reid. “It’s the duration that makes the difference in the investment.”
Capitol Bancorp stock is a pretty good medium of exchange to get, Reid says, and if the investors choose to take their gains right away, it’s a liquid public stock.
“The worst deal we ever had was something around a buck thirty five on a buck,” says Reid. “And that’s a pretty good investment right there.” — Steve Cocheo
The electronic version of this article available at: http://lb.ec2.nxtbook.com/nxtbooks/sb/ababj0507/index.php?startid=30
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